How To Build An Ideal Global Property Investment Portfolio In 2016
Investment professionals in the United States are trained on financial products. As a result, the investment and retirement portfolios that most of them recommend include paper investments only, in three categories—stocks, bonds, and cash.
Depending on your age and your risk tolerance, most financial advisors will tell you to put some percentage of your investment portfolio into stocks (riskier and longer-term), another percentage into bonds (lower risk and medium-term), and the balance into cash (zero risk and short-term).
Some advisors focus on specific industries or domestic versus international offerings. Some throw metals into the mix.
Real estate is rarely, if ever, seen in an investment portfolio pie chart.
It’s not because investment advisors as a rule think that real estate is a bad investment. They just aren’t in the business of selling real estate. They have financial investments to sell you… so that’s what they’re going to recommend you use to build your portfolio. If you want some real estate exposure, they’ll suggest a REIT.
That approach has never made sense to me, including when I was studying it in graduate school. Historically, many of the world’s richest people have had real estate to thank for their wealth. That fact alone should be enough to make the case that it’s counterintuitive to exclude real estate from your investment portfolio.
Real estate has always been my preferred investment class, and my investment portfolio has the reverse problem of the portfolios most financial advisors create—it’s heavy real estate. That is, more than 90% of my investment portfolio is invested in property in some form. The rest is in cash and metals. The few stocks I have owned over the years haven’t done well, and mutual funds are simply fee-generation mechanisms for the managers in my view. Few beat the market over any period of time.
I’m not recommending that you put all your investment eggs in real estate. What I am saying is that real estate is key to any diversified investment portfolio. Further, whatever real estate assets you invest in should be diversified, as well, including and especially by country.
How To Invest In Real Estate
Real estate diversification comes in three parts—the location of the property (I’m referring to market, not street address), the currency the property is valued in, and the property type.
Right now, if you’re an investor with U.S. dollars in your pocket, you’re riding high. The U.S. dollar is soaring against currencies worldwide, including in some of the markets I think make greatest sense for the property investor.
The euro has been trading as low as US$1.03 as we turn the calendar to New Year 2017 and trades at US$1.05 as I write.
Colombia is another top example. U.S. dollar investors have the chance to buy into this market today for the same prices, in U.S. dollar terms, as seven years ago. It’s your second bite at this apple.
Your property investment portfolio should be diversified as to market and currency. In addition, it should cover the asset bases.
By asset diversification, I don’t mean investing in a two-bedroom rental and a three-bedroom rental in different neighborhoods of the same city. You need to look at different types of real estate.
Take a look at this pie chart:
As this shows, broadly speaking, your options break down as follows:
- Rental property, short or long term, residential or commercial
- Land… for land banking or development
- Indirect investment
Each asset type comes with pluses and the minuses.
While you should see some appreciation on a rental investment to help boost your overall returns, your main expectation for return on investment in this case is the net yield from rental cash flow. Non-agricultural land, on the other hand, doesn’t generate a rental yield. In this case, you’re looking for all of your return from the appreciation of the property.
Land banking can have tremendous upside if you buy right, but one big benefit of owning land is that it has little downside if you buy right. It is a store of wealth with minimal carrying costs (usually nothing more than property taxes). You may want to keep the land cleared, and you might have an HOA fee if the land is part of a development. Otherwise, little is required out-of-pocket to hold a piece of land as long as you want to hold it.
The point of an agricultural investment is a cash return, annually from crops or productive trees (fruit or nut) or every 12 to 25 years in the case of a timber plantation.
You don’t have to be a farmer to make money from agricultural land today. This is a breakthrough reality of our times for us global property investors, and turnkey agricultural offerings are a constant focus.
The final category on my list of possible asset categories—”Indirect Investment”—refers to any property investment where you don’t own the real estate directly. This could be the REIT that your financial investment advisor suggested or it could be an investment in a company that develops real estate or a hard money loan. This is when an investor lends cash to a real estate entrepreneur (a developer or someone who does renovation projects, for example).
You lend the money for a short term at an interest rate that is much higher than would be typical for a bank loan. The developer is willing to pay the higher rate of interest because getting a bank loan would be too complicated or simply is not an option. You as the investor get the property (or a piece of the property, in the case of a big development) as collateral.
The risk with these options is that you don’t directly own or control the asset (the property). Some types of real estate can cross category lines. Pre-construction refers to an investment in a piece of real estate that is under construction or planned for construction. It could be a short- or long-term rental, residential or commercial, or maybe a condo hotel.
The advantage to buying this early is a reduced price, meaning you should expect good appreciation during the construction period. A pre-construction investment can be flipped to an end buyer when the building is close to completion or you can take possession of the unit and turn it into a rental yourself.
Renovation projects offer the same choices in the end—to flip or to rent. The upside appreciation potential of a renovation should translate to enough return to make the project worthwhile. Sometimes, though, even in a case of great appreciation, you find that you could get a great ongoing return on your investment by renting the property out.
The downside to renovations is the hard work and direct effort required on the investor’s part to make the project successful.
Creating Your Ideal Portfolio
Don’t worry. You don’t have to invest in all of these sub-categories to realize a reasonably diversified property portfolio. I offer these asset type options as a guide. An Ideal Portfolio might include them all, according to the percentages I laid out in my pie chart above.
However, few of us are going to build The Ideal Portfolio… and you don’t need to try. What you need to do at this point, as you set out to build not The Ideal Portfolio but the portfolio that is ideal for you, is to pin down the following:
- Your budget… how much money do you have available to put into your real estate portfolio
- Your level of risk tolerance
- Your diversification objectives (currency, country, category)
You may want or be able to invest in but one or two properties to get started. That’s ok. That’s the idea.
Let my Model Portfolio, as broken down in the pie chart above, be your guide as you work through all the decisions you’ll need to make as you consider a property investment opportunity.
Don’t get too bogged down in the percentages. They should be fluid.
And don’t be impatient. It’ll take time to create a broadly diversified international real estate portfolio. I’ve been at it for 20 years, and my portfolio remains a work in process. Considering new opportunities is a big part of the appeal and the fun.
“Lief, I am curious to know how a pass-through entity would soften the tax hit on any income for a U.S. taxpayer. As more stringent regulations are adopted in foreign countries regarding foreign residents and then passing along information to the respective jurisdictions about money transactions, it seems about the only thing a fictitious entity can provide is liability or probate protection.
“Keep up the good work.”
If an offshore corporation has passive income only, then it is considered a passive foreign income corporation (PFIC) and the income is taxed at onerous rates compared with income earned in a pass-through entity.
The other option would be to make the investment in your personal name, in which case the income would be reported directly on your personal tax return. In this case, your assets have no protection whatsoever and, as you suggest, the potential probate and inheritance issues can be costly.